The greenback is finding its footing once again after selling pressure intensified during yesterday’s session when President Trump doubled down on his attacks against Federal Reserve chair Jerome Powell. In a post on social media that landed after multiple firing threats, Trump demanded that the central bank deliver “pre-emptive” rate cuts, saying inflation is trending “nicely downward” and “There can be a SLOWING of the economy unless Mr. Too Late, a major loser, lowers interest rates, NOW”. Equity futures are setting up for a bounce at the open, yield curves are flattening, and currencies like the euro, pound, yen, and Canadian dollar are giving back some of their gains.
The assault on the Fed looks like a distraction. The Trump administration is well aware of the risks associated with firing the Fed chair – inflation expectations and long-term interest rates would almost certainly surge above today’s tariff-exacerbated levels, delivering a major growth shock – and Powell clearly serves a useful function in acting as a political scapegoat for the economy’s ills. Prediction markets agree: Polymarket is assigning just 22 percent odds to an early ouster.
The drama is nonetheless undermining confidence in US-denominated assets. Policy uncertainty is holding at levels exceeding those hit during the pandemic in early 2020, with businesses, investors, and consumers remaining deeply unsure about the government’s direction on trade, spending, taxation, central bank independence, and foreign relations. Tomorrow’s raft of domestic purchasing manager indices – along with the Fed’s Beige Book economic survey – will almost certainly illustrate the damage being inflicted on the American manufacturing sector, with “bullwhip” effects likely to show up in reported order volumes, inventory growth, and input prices. Expected growth differentials have narrowed against the United States, and real money flows – directed by large institutions with long-term investment objectives – are flooding into other countries as investors reassess the risks associated with an overconcentration in a single, increasingly unstable market.
But the “sell America” trade in foreign exchange markets is looking dangerously overextended. We highly doubt the dollar has permanently lost its safe haven appeal, given that the US retains the world’s deepest financial markets, biggest economy, and most powerful military — and that deeply-embedded network effects underpin the greenback’s dominance in trade, payments, cross-border financial flows, and debt intermediation. The American consumer market remains, by far, the biggest in the world*, meaning that a slowdown will undoubtedly have tertiary spillover effects in other countries.
A currency correction could unfold under two contradictory circumstances: At one extreme, if the Trump administration were to relax its stance on trade or back off attacks on the Fed, risk appetite could recover, squeezing out some of the short positions that have built up against the dollar. On the other, a seize-up in US financial markets or a tumbling of economic dominoes in other countries might force an unwind in cross-border lending and drive renewed demand in the Treasury markets.
The euro looks particularly vulnerable to a US-driven retracement. The common currency has now climbed almost 13 percent from its February lows, but its gains have come almost entirely at the dollar’s expense: the exchange rate has broken its long-standing relationship with interest differentials, suggesting that domestic European fundamentals aren’t playing a major role in driving price action.
The economic outlook has improved in response to a massive shift in Germany’s spending trajectory, a degree of insulation from the US-focused trade war, and hopes for more interest-rate cuts from the European Central Bank.
But the bloc is still facing serious headwinds. Germany’s fiscal expansion will take time to lift underlying growth rates, with the effects more likely to show up in 2026 than 2025. The euro’s sharp gains have already made exports less competitive – particularly relative to China – and the effective tariff rate on European shipments to the United States is now close to 10 percent, with the potential to go higher if pharmaceuticals and other products are brought into scope (as has been threatened). And sentiment levels remain extremely weak — tomorrow’s purchasing manager indices are likely to confirm a renewed erosion on both the manufacturing and services sides of the economy — meaning that the central bank’s easing efforts are unlikely to translate into a credit-driven rebound.
From a technical standpoint, the euro now looks overbought, with the exchange rate well above its 200-day moving average – something that has historically foreshadowed a correction – and we suspect that the currency will struggle to make sustained headway above the 1.15 threshold against the dollar. A push above 1.20 is possible in the event that the Trump administration succeeds in breaking the Fed, leading to Nixon-style outcomes in global financial markets, but this shouldn’t represent anyone’s base case.
